Norwalk, CT, July 31, 2002—The accounting for employee stock options has received renewed attention in recent months. Over the past few weeks there have been two important developments.

1. Several major U.S. companies have announced their intentions to change their method of accounting for employee stock options to an approach that recognizes an expense for the fair value of the options granted in arriving at reported earnings. We understand that a number of other companies also are considering adopting that method. The FASB applauds those companies because recognizing compensation expense relating to the fair value of employee stock options granted is the preferable approach under current U.S. accounting standards (FASB Statement No. 123, Accounting for Stock-Based Compensation). It also is the treatment advocated by an increasing number of investors and other users of financial statements. When the FASB developed FAS 123 in the mid-1990s, the Board proposed requiring that treatment because it believed that this was the best way to report the effect of employee stock options in a company’s financial statements. The FASB modified that proposal in the face of strong opposition by many in the business community and in Congress that directly threatened the existence of the FASB as an independent standard setter. Thus, while FAS 123 provides that expense recognition for the fair value of employee stock options granted is the preferable approach, it permitted the continued use of existing methods with disclosure in the footnotes to the financial statements of the pro forma effect on net income and earnings per share as if the preferable, expense recognition method had been applied. Until now, only a handful of companies elected to follow the preferable method.

2. The International Accounting Standards Board (IASB) has concluded its deliberations on the accounting for share-based payments, including employee stock options, and announced plans to issue a proposal for public comment in the fourth quarter of 2002. That proposal would require companies using IASB standards to recognize, starting in 2004, the fair value of employee stock options granted as an expense in arriving at reported earnings. While there are some important differences between the methodologies in the IASB proposal and those contained in FAS 123, the basic approach is the same—fair value measurement of employee stock options granted with expense recognition over the vesting period of the options.

The FASB has been actively working with the IASB and other major national standard setters to bring about convergence of accounting standards across the major world capital markets. The Board has been closely monitoring the IASB’s deliberations on share-based payments and urges all interested parties to submit comments to the IASB on its proposal once it is released later this year. Additionally, the FASB plans to issue an Invitation to Comment summarizing the IASB’s proposals and explaining the key differences between its provisions and current U.S. accounting standards. The FASB will then consider whether it should propose any changes to the U.S. standards on accounting for stock-based compensation.

In the meantime, in response to requests by companies considering switching to the preferable method under FAS 123, the FASB also plans to consider at its August 7 public meeting whether it should undertake a limited-scope, fast-track project relating to the transition provision in FAS 123. Literally applied, the existing transition provision in FAS 123 would require companies that elect to change to the preferable method to do so prospectively for stock options granted after the date of the change. This transition provision was appropriate when FAS 123 was issued in 1995 because, at that time, companies did not have valuation information available relating to previous grants of employee stock options. However, that is no longer the case given the disclosure requirements that have now been in effect since 1995 under FAS 123.

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Amendment to the Transition and Disclosure Provisions of Statement 123

Last Updated: August 14, 2002

The staff has prepared this summary of Board decisions for information purposes only. Those Board decisions are tentative and do not change current accounting. Official positions of the FASB are determined only after extensive due process and deliberations.

At its August 7, 2002 and August 14, 2002 Board meetings, the Board addressed issues related to the transition and disclosure provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, and made the following decisions:

1. In response to constituent requests, the Board decided to undertake a limited scope project to reconsider the transition and disclosure provisions of Statement 123.
2. The Board tentatively decided to permit enterprises that voluntarily adopt the fair value recognition provisions of Statement 123 to choose from one of the following three transition methods:
* Recognize stock compensation cost pursuant to Statement 123 for the year of change only for awards granted after the beginning of that fiscal year (prospective application only to new awards)
* Recognize stock compensation cost for the year of change equal to that which would have been recognized had Statement 123 been adopted as of its effective date (prospective application to new awards and unvested portions of awards granted since the effective date of Statement 123)
* Recognize stock compensation cost for the year of change and restate prior years’ financial statements presented as though Statement 123 had been adopted as of its effective date. Under this approach, the cumulative effect of retroactively applying Statement 123 for financial statements not presented would not be reflected as of the beginning of the earliest year presented. Restatement of years prior to the earliest period presented would not be required, but would be permitted.

3. The Board decided to amend the disclosure requirements in paragraph 45 of Statement 123 to require that all companies disclose the following in the accounting policy note to the financial Statements for each period for which an income statement is presented:

* The method of accounting for stock options
* Total stock compensation cost recognized in the income statement
* Total stock compensation cost that would have been recorded had Statement 123 been adopted as of its effective date
* Pro forma net income and earnings per share that would have been reported had Statement 123 recognition provisions been adopted as of its effective date.

4. The Board decided to require disclosure of the information described in Item 3 in quarterly information provided to shareholders.

5. The provisions of the Statement related to transition and disclosure in annual financial statements would be effective upon issuance of a final Statement. The provisions of the Statement related to the quarterly disclosure requirement would be effective in the first interim period of fiscal years beginning after December 15, 2002, with earlier application encouraged.

6. The Board decided to issue an Exposure Draft of a proposed Statement for a 30-day comment period. The Board expects to issue that Exposure Draft in late September.

The key here IMHO is uniform guidelines. While stock option information is mandatory in certain SEC filings and reports, an established standard will need to be used to make the information useful and accurate for purposes of comparing financials between companies in the same industries.

Guest, why don’t you register and become a regular contributor to the forums?

Here’s a question: Are voluntary guidelines enough to satisfy the investing public or should this be made mandatory?

It’s of little value IMHO unless all companies uses the same guidelines and report the expense in the same way.